SocGen expects volatility leaps in the coming months

04/03/2018

Volatility in the markets can last for a long time, but investors have many ways to prepare for it.

PIX1861 via flickr

Société Générale SA's strategists in the second quarter forecast points to "hedging against volatility outbreaks typical for the late stage of the cycle, in credit markets, in dispersion strategies and volatility of all asset classes, as the correlation between shares and bonds itself becomes more volatile."

The strategists warn that technological innovations, such as algorithmic trading, are exacerbating trade problems, and are leading to strong "market liquidity distortions." As an example, the report provides a volatility spiral, observed in early February.

Société Générale notes that in 2018 the net inflow of liquidity provided by all central banks will be negative for the first time since 2009. This will create the prerequisites for a regime change in terms of both correlations and volatility in different classes of assets, as well as premiums for risk.

The Cboe Volatility index jumped 81% in the first quarter. In January, the S&P 500 showed the largest increase in 22 months, as optimism about the tax reform in the US triggered a record inflow into US stocks. However, in early February, signs of increased inflationary pressures provoked turmoil in the markets. As a result, there was a 10% correction.

March did not bring peace to investors. They were concerned about the personnel reshuffle in the White House, the risks of a "trade war" with China and the fall in shares of technological giants on fears of toughening of control by regulators. By the end of the quarter, the S&P 500 has lost 1.2%.

For a long time, fears about an increase in Fed rates are likely to fuel the volatility. In March, the Fed, as expected, raised the federal funds rate by 25 basis points to 1.5-1.75% per annum.

The US Central Bank still expects that the interest rate will be raised two more times in 2018, although some investors believed that the Fed will forecast another three rate hikes this year.